The owner of Hansson Private Label (HPL) must determine whether or not to accept an aggressive expansion project that would preclude the company from pursuing any alternative investment opportunities for several years. The investment, if successful, would offer numerous benefits to the company, capturing greater market share, strengthening relationships with major customers, crowding out competition and increasing firm value. Nonetheless, the decision carries significant risks and could lead to a substantial decline in firm value, if not bankruptcy, should any number of variables prove unfavorable to HPL. Moreover, the project relies heavily on a contract with a single large …show more content…
Of course, there are several potential—not to mention highly attractive—upsides to the pursuit of the project. In addition to adding value to the firm, the expansion could bolster HPL’s position in the private labels manufacturing sector, increasing market share, strengthening relationships with retail customers, and expanding production capacity. If HPL had unlimited investment capital at its disposal, my recommendation might be different; however, it is clear that acceptance of this project would cause the company to forgo all other investment opportunities for the foreseeable future. It is this fact that is most concerning to me, and which renders the investment too risky in my opinion.
A better alternative might be to pursue a series of smaller projects that do not rely on a contract with a single customer. In addition to mitigating risk, this more conservative approach could in fact result in a higher conglomerate NPV if the projects are chosen strategically. HPL should employ capital rationing using a profitability index in evaluating investment alternatives. One potential project worth analyzing would be the acceptance of the three-year contract under